By Karen Pierog and Kate Duguid
April 14 (Reuters) – A funding backstop the U.S. Federal Reserve launched on Tuesday will help address liquidity problems that have lingered in the coronavirus-roiled commercial paper market.
The Commercial Paper Funding Facility’s special purpose vehicle purchases higher rated, three-month unsecured and asset-backed paper from eligible bank, corporate, special-purpose entity and municipal issuers using financing from the New York Federal Reserve. The vehicle, which was announced on March 17, began making purchases on Tuesday according to the New York Fed.
The program is similar to an operation used during the 2008 financial crisis, in which the central bank acts as a lender of last resort for companies otherwise unable to borrow in the short-term market.
“The Fed’s liquidity injections are working,” said Zoltan Poszar, money market analyst at Credit Suisse. “Global dollar funding conditions have eased, and U.S. dollar Libor-OIS spreads started to tighten.”
“Just knowing it is available has helped to calm the market,” said Kevin Giddis, head of fixed income at Raymond James.
Short-term credit markets had come under strain amid worries that companies hit by efforts to slow the spread of the virus would not be able to repay their IOUs. That spurred the Fed to take steps aimed at thawing out markets frozen by spiking lending rates.
Deborah Cunningham, chief investment officer at Federated Hermes in Pittsburgh, said the move will provide a backstop for the market.
“I don’t know that it’s going to get a whole lot of utilization,” she said. “Having said that, I think it’s good that it’s there and it adds sort of a floor if spreads started to get too wide for whatever reason.”
Cunningham added that issuers may not like the fee they are required to pay to participate in the program. The 10-basis-point “facility fee” is based on the maximum amount of an issuer’s commercial paper that the special purpose vehicle may own.
The Federal Reserve said on March 17 that each user must pay a fee of 10 basis points of the maximum amount outstanding over last year.
The facility is funded with $10 billion in equity from the U.S. Treasury, which the Fed is expected to leverage as much as 10 times should demand warrant.
Companies rely on commercial paper as a source of short-term cash for payrolls, inventory and accounts payable as well as unanticipated funding needs.
Since the introduction of its facility, rates across maturities for both high-grade and lower-grade paper have fallen.
The average rate for overnight AA nonfinancial paper was 1.56% in February, 0.86% in March and is currently at 0.05% for April. For lower-grade A2/P2 overnight nonfinancial paper that rate dropped from 2.31% in March and is currently at 1.52% for April.
Earlier this month, the New York Fed announced it hired Pacific Investment Management Company (PIMCO) to serve as investment manager for the facility and retained State Street Bank & Trust Company to be the custodian and accounting administrator.
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